How Traders Use the Bullish Percent Index to Find the Dominant Trend

Traders sometimes use the bullish percent index (BPI) to fine-tune and confirm trading signals you see on the weekly index charts. The BPI is a powerful indicator that shows the percentage of stocks that have generated buy signals compared with the total number of stocks in a given index.

This indicator originally was used to track all the stocks on the NYSE, but it also can be applied to any broad market index, including the S&P 500, the NASDAQ Composite, or even the more narrowly defined NASDAQ 100 and sector indexes. BPI provides fewer and better signals when evaluating larger groups of stocks.

The BPI is based on point-and-figure charts — probably the oldest and simplest stock charting technique — and helps you evaluate the strength of the market as a whole. Calculating the BPI is a bit daunting, but fortunately, it’s published online. For example, you can find BPIs at StockCharts.com, where the current states of this indicator for the major indexes and several sector indexes are displayed and interpreted.

BPI works somwehat like an oscillator. It displays values ranging from 0 to 100 percent to identify oversold and overbought market conditions. When fewer than 30 percent of all stocks are on a buy signal, the BPI shows that the market is oversold and ripe for turnaround. When more than 70 percent of all stocks signal a buy, the BPI shows the market is overbought and ripe for a downturn.

However, like individual stocks, broad market indexes can remain overbought or oversold for extended periods of time, so by themselves, BPI readings below 30 percent or above 70 percent don’t necessarily represent respective buy or sell signals. BPI can and does provide readings well above 70 percent and well below 30 percent for extended periods of time.

Changes in BPI levels are triggered by reversal patterns. A 6 percent change in the stocks of a given index is required to trigger any changes (up or down) in the BPI. These reversal patterns are interpreted to describe the state of the market using six unique conditions that roughly correspond with the six phases of the market. Here are the six states of the BPI:

Bull alert: Corresponds with the bullish transition phase. It’s triggered when the BPI is less than 30 percent and reverses direction when 6 percent (or more) of all stocks change to buy signals.

Bull confirmed: Corresponds with the bull market phase. When the BPI indicator forms a higher high, a bull market is confirmed.

Bull correction: Corresponds with the bullish pullback phase. This condition occurs only after the BPI confirms a bull market and a minimum of 6 percent of all stocks change from buy to sell signals. If the BPI is greater than 70 percent, this change may lead to a bear alert.

Bear alert: Corresponds with the bearish transition phase. It’s triggered when the BPI is greater than 70 percent and reverses direction after 6 percent of all stocks change to sell signals.

Bear confirmed: Corresponds with the bear market phase. When the BPI indicator forms a lower low, a bear market is confirmed.

Bear correction: Corresponds with the bearish pullback phase. This condition occurs only after the BPI confirms a bear market and at least 6 percent of all stocks change from sell to buy signals. If BPI is less than 30 percent, this change may lead to a bull alert.

Although BPI is not a leading indicator, it gives you a good feel for the overall health of the market. When used with broad-based indexes, the BPI doesn’t speak often. After all, more than 1,800 stocks are traded on the NYSE.

For the BPI to register a reversal, at least 6 percent (or approximately 112) of those stocks must change from a buy signal to a sell signal (or vice versa). Actually, the distinction’s a bit more subtle than that. A total of 112 more stocks must change to sell signals than are changing to buy signals for the index to change from bull confirmed to bull correction conditions.

The BPI for smaller stock indexes generates considerably more signals. A 6 percent change on the NASDAQ 100 requires only a balance of six stocks to change from buy to sell signals. Although the BPI provides information about the condition of these smaller indexes, you must use the signals with care. This indicator is best used with broader-based indexes such as the NASDAQ Composite, the NYSE, and the S&P 500.

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